Drive Time Increases Odds of Deducting Rental Property Losses

by | Oct 15, 2018 | Blog, Taxes | 0 comments

Your rental properties provide tax shelter when you can deduct your losses against your other income. One step to deducting the losses is to pass the tax code’s 750-hour test. And one step to finding the hours you need to pass the time test may be your drive times.

Trzeciak Case

Mariam Trzeciak owned, managed, and rented 14 single-family homes in and near Columbus, Ohio. She and her husband, Marc, on their joint tax returns claimed rental property losses of $126,376 and $151,884 in the two years that were subject to this IRS audit.

The IRS revenue agent assigned to examine the Trzeciaks’ returns disallowed the losses as passive losses, claiming that Mariam did not qualify as a real estate professional because she could not count her drive time from her home near Dayton to Columbus, where the properties were.

It took Mariam’s , who prepared her returns and assisted with the audit, and then her lawyers almost three years to surface the home-office deduction as the savior. Once it surfaced, the IRS allowed the drive time, and that allowed Mariam to deduct her rental property losses of $126,376 for year 1 and $151,884 for year 2.

Leland Case

In Leland, Clarence McDonald Leland traveled 13 to 16 hours from Mississippi to Texas and back several times each year to perform necessary work on his 1,276-acre farm in Turkey, Texas.

The court noted that the IRS did not object to the inclusion of the travel time in determining Clarence’s participation in the farm. And the court went on to say: “The facts of this case establish that petitioner’s [Clarence’s] travel time was integral to the operation of the farming activity rather than incidental.”

Leyh Case

The Leyh case involved Richard Leyh and Ellen O’Neill. Ellen owned 12 rental properties in Austin, Texas, about 26 to 30 miles from her home at a ranch in Dipping Springs, Texas.

Ellen and Richard deducted a $69,531 loss from their rental operations. The IRS said no because Ellen, without inclusion of her drive time, failed the 750-hour test to establish herself as a real estate professional.

The sole question that the court had to address was whether Ellen could include her drive time from her home to the rentals as rental property time. Interestingly, she failed to include her travel time in her well-kept log of time and had to reconstruct that travel time for the court.

The court ruled that her reconstruction of the travel time to and from the properties was adequate and ruled that she and Richard could deduct her $69,531 in on their joint tax return.

What You Should Do

Take the steps necessary to make your rental property drive time count as material participation time. The first step is to keep an accurate log of the time that you spend on your rentals (yes, we know this is a pain—but suffer a little and just do it).

Audit-Proof Your Time Spent on Rental Properties

If you claim status as a tax law–defined real estate professional who can deduct his or her rental property losses, your time record for the year must prove that you spent

  1. more than one-half of your personal service time in real property trades or businesses in which you materially participate, and
  2. more than 750 hours of your personal and investor services time in real property trades or businesses in which you materially participate.

If you are married, either you or your spouse must individually qualify as a real estate professional. If one spouse qualifies, both spouses qualify.

Achieving real estate professional status is the first of two steps. You face one additional hurdle. To deduct tax losses on a rental, you also must prove that you materially participated in the rental activity. If you are married, you and your spouse may count your joint efforts toward passing the material participation tests.  Most of the tests for material participation are based on hours worked.

What Does This Mean to You?

In simple terms: keep a time log. In an audit of your real estate activity, the IRS tells its examiner:

Request and closely examine the taxpayer’s documentation regarding time. The taxpayer is required under Reg. Section 1.469-5T(f)(4) to provide proof of services performed and [of] the hours attributable to those services.

If you don’t have what the IRS wants, your odds of winning your rental loss deductions are slim, if that. And don’t think you can create this log after the fact. Most everyone who spends the considerable time it takes to jump through the hoops to create an after-the-fact log of hours using the IRS spreadsheets loses the deductions.

Changes to Net Operating Losses After Tax Reform

Tax reform made many good changes in the tax law for the small-business owner. But the changes to the net operating loss (NOL) deduction rules are not in the good-changes category. They are designed to hurt you and put money in the IRS’s pocket.

Now, if you have a bad year in your business, the new NOL rules are designed to stop you from using your business loss to find some immediate cash. The new (let’s call them bad-for-you) rules certainly differ from the prior beneficial rules.

Old NOL Rules

You have an NOL when your business deductions exceed your business income in a taxable year. Before tax reform, you could carry back the NOL to prior tax years and get refunds of paid in those prior years.

Alternatively, you could have elected to waive the NOL carryback and instead carry forward the NOL to offset some or all of your taxable income in future tax years.

New NOL Rules

Tax reform made two key changes to the NOL rules:

  1. You can no longer carry back the NOL (except for certain qualified farming losses).
  2. Your NOL carryforward can offset only up to 80 percent of your taxable income in a tax year.

The changes put more money in the IRS’s pocket by

  • eliminating your ability to get an immediate tax benefit from your NOL carryback, and
  • delaying your ability to get tax benefits from future NOL carryforwards.

We are bringing the NOL rules to your attention in case you need to do some planning with us. We likely have some strategies that can help you realize some immediate benefits from your business loss.

Take Money Out of Your IRA at Any Age Penalty-Free

You probably think you can’t take money out of your IRAs before age 59 1/2 unless you meet a narrow exception to the unpleasant 10 percent penalty on early distributions. But that’s not true. We have a variety of planning opportunities here.

For example, you don’t pay or the 10 percent penalty on amounts you withdraw that you previously contributed or converted to the Roth IRA. These amounts are your “basis” in the Roth IRA. (Remember, you funded your Roth IRA with after-tax money!)

The law says Roth distributions come out in the following order:

  • regular contributions,
  • rollover contributions, and finally
  • earnings.

Example. Jane opened her Roth IRA in 2002. She contributed $30,000 over the life of the Roth IRA. Today, the account is worth $50,000. Jane can withdraw up to $30,000 tax-free and penalty-free regardless of her age.

If you made nondeductible contributions to a traditional IRA, then you have “basis” in all your traditional IRAs. With basis, you have some planning opportunities with your business’s qualified plans, such as your 401(k).

And then, on a totally different front, there’s a little-known escape from the 10 percent penalty, called the substantially equal periodic payment exception. It allows you to create a stream of penalty-free traditional IRA distributions starting at any age for any reason.

You have to continue the substantially equal periodic payments for at least five years or until you reach age 59 1/2, whichever is later. As you can see from the above, you can touch your IRA accounts before age 59 1/2 without a special reason.

MORE ARTICLES FROM OUR BLOG

GP CPA Client’s Letter – May 2019

Dear Client: It was good seeing you both again. Each time we meet the numbers and growth are getting better and better. The key items we spoke about during the meeting are as follows: The 2018 personal due, totaling about $20K, were a "best case scenario"...

Backdoor Roth IRA Opportunities Still Available After TCJA

Backdoor Roth IRA Opportunities Still Available After Good news. () did not harm the backdoor .As you likely know, the Roth IRA is a terrific way to grow your wealth with a minimum tax downside because you pay the taxes...

S-corporations – What’s not to love?

The majority of GP ’s clients own and operate S-corporations (“”), as our firm specializes in the administration, accounting, and taxation that is unique to this type of business entity. Most types of businesses can be an and from our perspective, the...

[Frequently Asked Questions] CFP (Certified Tax Planner)

Recent client question from a CFP (Certified Tax Planner) to GP : “I wanted to reach out because I have a client that has a portfolio that is 100% equity in a taxable account.  We are looking to sell out of the equity positions and redeploy the proceeds into a...

Test your knowledge about NC Sales Tax for HVAC Services

If your business involves repairs, maintenance, or installation services related to vehicles then this quiz will test your knowledge of current law. MORE ARTICLES FROM OUR BLOG
Tina Simmons
Tina Simmons
13:38 17 May 19
This team is dedicated to their clients and committed to understanding your business and sharing their knowledge to help you succeed. I love working with these folks, they take the worry and uncertainty out of accounting and taxes!read more
Bravo4 Autowerks
Bravo4 Autowerks
12:55 08 May 19
Gary and his team have been fantastic for me and my business. They respond well to all my questions, are very helpful and of course keep my financials in order. Highly recommended.read more
Queen City Newborn Care
Queen City Newborn Care
15:57 02 Apr 19
I was drowning before I met Justin. He totally transformed how I run my small business and has gotten me organized in ways I didn't even know were possible. I am so grateful for his advice and suggestions! This company is worth every penny.read more
Dennis Bloomberg
Dennis Bloomberg
16:01 26 Mar 19
Unfortunately, I found GMP when my mother passed. She had a trust set up and I had no experience with one. I received excellent advice prior to filing taxes, that allow for the transfer of assets with little tax implication. The tax process was simple for me, Justin took over once he had details and cleared up all question from filing our taxes. Thank you for a job well done!read more
Natalie Knight
Natalie Knight
15:35 21 Nov 18
is up to date on technology. They handcraft a platform that works best for your company's accounting services. We really appreciate how hands on and quick their team is when replaying to any type of correspondence. Simply put, they care and want your company to succeed.read more
Ashlyn Lelej
Ashlyn Lelej
14:39 21 Nov 18
I highly recommend Justin at , CPA for all of your accounting and tax needs. I've been a client for over two years, and have been consistently impressed with their dedication to helping my business grow and be financially successful. His advice is invaluable. Thank you!read more
Bobby Nguyen
Bobby Nguyen
22:23 20 Nov 18
My partner and I started our very first small business last year. Justin has been a blessing to us. Being new at all of this, we didn’t understand much of how business taxes work. Justin explained and answer all of questions that we have. He took care of everything for us throughout the year and have made life so much easier for us. I couldn’t have asked for a better CPA. Highly recommended!read more
Next Reviews

CATEGORIES

Are you living in the most tax-friendly state?
How to create the paper trail for rental real estate deductions